Should we fear a trade backlash?


Economic aspects of the 1930s many of us thought we would never see in our lifetime have reared their ugly heads again






With more than a whiff of depression in the air, is a Smoot-Hawley-like backlash against trade about to follow? It was the collapse of GNP in 1929-30 that led the US Congress to impose the tariff that caused the unravelling of world trade. Might the same happen again?


The danger exists. If the past months have taught us one thing, it is that anything is possible. Other economic aspects of the 1930s that many of us thought we would never see in our lifetimes have reared their ugly heads. Google News listed 181 articles mentioning "Smoot Hawley" this week.


Some of these fears relate to the protectionist rhetoric of Barack Obama during the Ohio primary and his opposition to the Colombian and South Korean free trade agreements. Then there are the bailouts for General Motors and Chrysler. A subsidy for domestic auto producers is fun.ctionally equivalent to a tax on the US sales of foreign producers. Finally there is the fear that the US fiscal stimulus package about to be adopted will be rendered less effective if the increased demand is allowed to leak out in the form of increased imports. US politicians will be quick to react with protectionist measures if they see that today's spending programmes, which create a debt burden for future generations, fail to stimulate the American economy and only benefit other countries.


Fortunately there are reasons for thinking that this danger is overstated. First, the growth of multinational production and global supply chains has altered the political economy. Protecting US auto producers no longer automatically benefits US parts suppliers when the Big Three source many of their parts from Canada. Foreign companies with an interest in the maintenance of free and open trade are better represented in the political process than they were in the 1930s. We saw this in the debate over the auto bailout when the "Senator from Honda", Richard Shelby, argued against the provision of federal funds.


Second, in 1930 Congress resorted to Smoot-Hawley out of desperation over its lack of alternatives. It was not that the Congress then, as some suggest might be the case now, resorted to a tariff to maximise the employment-creating impact from expansionary fiscal policies. Rather the tariff was imposed instead of expansionary fiscal policies, there as yet being no understanding of the case for fiscal stimulus.
The danger of a tariff as a convoluted employment-creating policy is now less, precisely because we understand that there are direct ways for the government to stimulate demand, namely by cutting taxes and raising public spending.


Finally, if fiscal stimulus and the Fed's zero interest rate policy mainly suck in imports, then the dollar will decline in response to the widening current account deficit. This will shift demand back toward domestic goods, venting the pressure for a protectionist response. This is no mere hypothetical: we have already seen the dollar falling in anticipation of just these developments. This is fundamentally different from 1930, when the US and other countries were on the gold standard and there was no scope for the exchange rate to adjust.



This suggests that a better analogy than Smoot-Hawley is the British General Tariff of 1932, imposed after the UK abandoned the gold standard. Sterling had already depreciated substantially, raising the prices of imports relative to British goods and rendering the tariff redundant. With sterling floating, the decline in imports induced by the tariff just put upward pressure on the exchange rate, neutralising most of the change in relative prices. As a result, the employment-creating effects of the tariff were somewhere between minimal and non-existent. This has been well known since a Yale University dissertation was written on this particular series of events 30 years ago. (No bonus points for guessing the identity of the author.)


If the General Tariff had been rendered redundant, then why was it imposed? The simple answer is that, with unemployment rates of 20 per cent, British politicians were desperate to do something, and they had few other instruments at their disposal. To be sure, there was "cheap money" – the 1930s equivalent of today's zero-interest-rate policy. But there was no certainty that this would work, just as there are questions today about whether, with banks reluctant to lend, the Fed is simply pushing on a string. And, as already noted, there was no understanding of the role for fiscal policy.





Today, in contrast to the 1930s, our politicians have no shortage of policy levers. They just need to pull the right ones.

Protectionism
The battle of Smoot-Hawley

Dec 18th 2008
From The Economist print edition

Hawley and Smoot, the bogeymen of trade

A cautionary tale about how a protectionist measure opposed by all right-thinking people was passed






EVEN when desperate, Wall Street bankers are not given to grovelling. But in June 1930 Thomas Lamont, a partner at J.P. Morgan, came close. “I almost went down on my knees to beg Herbert Hoover to veto the asinine Hawley-Smoot Tariff,” he recalled. “That Act intensified nationalism all over the world.”


According to David Kennedy, an historian, Lamont was “usually an influential economic adviser” to the American president. Not this time. Hoover signed the bill on June 17th: “the tragic-comic finale”, said that week’s Economist, “to one of the most amazing chapters in world tariff history…one that Protectionist enthusiasts the world over would do well to study.”



The Tariff Act of 1930, which increased nearly 900 American import duties, was debated, passed and signed as the world was tumbling into the Depression. Its sponsors—Willis Hawley, a congressman from Oregon, and Reed Smoot, a senator from Utah—have come to personify the economic isolationism of the era. Sixty-three years later, in a television debate on the North American Free-Trade Agreement, Al Gore, then vice-president, even presented his unamused anti-NAFTA opponent, Ross Perot, with a framed photograph of the pair. Now, with the world economy in perhaps its worst pickle since the Depression, the names of Hawley and Smoot are cropping up again.


In fact, few economists think the Smoot-Hawley tariff (as it is most often known) was one of the principal causes of the Depression. Worse mistakes were made, largely out of a misplaced faith in the gold standard and balanced budgets. America’s tariffs were already high, and some other countries were already increasing their own.


Nevertheless, the act added poison to the emptying well of global trade (see chart). The worldwide protection of the 1930s took decades to dismantle. And bad monetary and fiscal policies were at least based on the economic orthodoxy of the day: economists would tear each other apart over the heresies of John Maynard Keynes. On protection, there was no such division. More than a thousand economists petitioned Hoover not to sign the Smoot-Hawley bill. Bankers like Lamont sided with them; so did editorialists by the score.

The “asinine” bill began as a much smaller beast: the plan was to help American agriculture, which had slumped in the early 1920s. Congress passed several bills to support prices and subsidise exports, but all were vetoed by Calvin Coolidge, Hoover’s predecessor. With no obvious logic—most American farmers faced little competition from imports—attention shifted to securing for agriculture the same sort of protection as for manufacturing, where tariffs were on average twice as high. To many of its supporters, “tariff equality” meant reducing industrial duties as well as raising those on farm goods. “But so soon as ever the tariff schedules were cast into the melting-pot of revision,” this newspaper wrote, “logrollers and politicians set to work stirring with all their might.”


Start rolling


In the 1928 election campaign Hoover and his fellow Republicans promised to revise the tariff. The Democrats, then the freer-trading party, were unusually acquiescent. After comfortable Republican wins in November, Hawley, the chairman of the House Ways and Means Committee, set to work. By the time Hoover was inaugurated in March 1929 and called a special session of Congress to tackle the tariff, his committee had gathered 43 days’, five nights’ and 11,000 pages’ worth of testimony. The door was open to more than just farmers; Hawley’s committee heard mainly from small and medium-sized industrial businesses.



The House bill, passed in May, raised 845 tariff rates and cut 82. Douglas Irwin, an economist at Dartmouth and author of a forthcoming book (“The Battle over Protection: A History of US Trade Policy”) on which this article draws heavily, says it “tilted the tariff nearly as much toward higher duties on manufactured goods as it increased duties on agricultural imports.”


The bill then went to the Senate, where Smoot chaired the Finance Committee. Senators who thought their constituents had lost out in the House—from farming and mining states—were spoiling for a fight. Smoot’s committee increased 177 rates from the House version and cut 254. In the next committee stage—which lasted from the autumn of 1929 until March 1930—the whole Senate could take part. Farming- and mining-state senators pruned Hawley’s increases in industrial tariffs.


In the last Senate stage, senators from industrial states regrouped, fortified by the gathering economic gloom. “A different voting coalition emerged,” says Mr Irwin, “not one based on agricultural versus industrial interests but on classic vote-trading among unrelated goods.” Some senators disapproved: Robert LaFollette, a Republican from Wisconsin, called the bill “the product of a series of deals, conceived in secret, but executed in public with a brazen effrontery that is without parallel in the annals of the Senate.”


Others saw nothing wrong. Charles Waterman, a Republican from Colorado, declared: “I have stated…that, by the eternal, I will not vote for a tariff upon the products of another state if the senators from that state vote against protecting the industries of my state.” The tariff’s critics—including Franklin Roosevelt, in his presidential campaign in 1932—dubbed the bill the “Grundy tariff”, after Joseph Grundy, a Republican senator from Pennsylvania and president of the Pennsylvania Manufacturers’ Association. Grundy had said that anyone who made campaign contributions was entitled to higher tariffs in return.


The Senate’s final bill contained no fewer than 1,253 changes from the House’s version. The two houses compromised, broadly by moving the Senate’s rates up rather than the House’s down. In all, 890 tariffs were increased, compared with the previous Tariff Act, of 1922, which had itself raised duties dramatically (for examples, see table); 235 were cut. The bill squeezed through the Senate, by 44 votes to 42, and breezed through the House.

Of all the calls on Hoover not to sign the bill, perhaps the weightiest was a petition signed by 1,028 American economists. A dozen years later Frank Fetter, one of the organisers, recalled their unanimity. “Economic faculties that within a few years were to be split wide open on monetary policy, deficit finance, and the problem of big business, were practically at one in their belief that the Hawley-Smoot bill was an iniquitous piece of legislation.”


Some of the names are familiar even now. One was Frank Taussig, a former head of the Tariff Commission (which advised on whether duties should be raised or lowered). Another was Paul Douglas, later a senator (undergraduates are still introduced to the Cobb-Douglas production fun.ction). And a third was Irving Fisher.


Fisher is still a giant of economics, best known for his work on monetary theory and index numbers. (He was fallible, though. Shortly before the 1929 stockmarket crash, he declared, “Stock prices have reached what looks like a permanently high plateau.”) According to Fetter, Fisher suggested that the petition refer explicitly to the importance of trade to America as a huge creditor nation: if other countries could not sell to the United States, how could they repay their debts? It was also thanks to Fisher that so many economists signed it. He proposed that it be sent to the entire membership of the American Economic Association, rather than to one member of each university’s faculty, and offered to meet the extra expense. The total cost was $137, of which Fisher paid $105.


Expensive ink


Hoover’s signature cost rather more—even though the direct effect on American trade was limited. The average rate on dutiable goods rose from 40% to 48%, implying a price increase of only 6%. And most trade, Mr Irwin points out, was free of duty (partly because high tariffs discouraged imports). He estimates that the new tariff reduced dutiable imports by 17-20% and the total by 4-6%. Yet the volume of American imports had already dropped by 15% in the year before the act was passed. It would fall by a further 40% in a little more than two years.


Other, bigger forces were at work. Chief among these was the fall in American GDP, the causes of which went far beyond protection. The other was deflation, which amplified the effects of the existing tariff and the Smoot-Hawley increases. In those days most tariffs were levied on the volume of imports (so many cents per pound, say) rather than value. So as deflation took hold after 1929, effective tariff rates climbed, discouraging imports. By 1932, the average American tariff on dutiable imports was 59.1%; only once before, in 1830, had it been higher. Mr Irwin reckons that the Tariff Act raised duties by 20%; deflation accounted for half as much again.


Smoot-Hawley did most harm by souring trade relations with other countries. The League of Nations, of which America was not a member, had talked of a “tariff truce”; the Tariff Act helped to undermine that idea. By September 1929 the Hoover administration had already noted protests from 23 trading partners at the prospect of higher tariffs. But the threat of retaliation was ignored: America’s tariffs were America’s business. The Congressional Record, notes Mr Irwin, contains 20 pages of debate on the duty on tomatoes but very little on the reaction from abroad.


A study by Judith McDonald, Anthony Patrick O’Brien and Colleen Callahan* examines the response of Canada, America’s biggest trading partner. When Hoover was elected president, the Canadian prime minister, Mackenzie King, wrote in his diary that his victory would lead to “border warfare”. King, who had cut tariffs in the early 1920s, warned the Americans that retaliation might follow. In May 1930, with higher American tariffs all but certain, he imposed extra duties on some American goods—and cut tariffs on imports from the rest of the British empire.

He promptly called a general election, believing he had done enough to satisfy Canadians’ resentment. America, wrote the New York Times, was “consciously giving Canada inducements to turn to England for the goods which she has been buying from the United States.” Canadians agreed. King’s Liberals were crushed by the Conservatives, who favoured and enacted even higher tariffs.


All this, of course, is history. There are plenty of reasons to think that the terrible lesson of the 1930s will not have to be learnt again. Governments have reaffirmed their commitment to open trade and the World Trade Organisation (WTO). The complex patterns of cross-border commerce, with myriad stages of production spread over so many countries, would be enormously costly to pull apart.


And yet. Tariffs can be increased, even under the WTO. The use of anti-dumping is on the rise. Favours offered to one industry (farming then; cars now?) can be hard to refuse to others. And the fact that politicians know something to be madness does not stop them doing it. They were told in 1930: 1,028 times over.





* “Trade Wars: Canada’s Reaction to the Smoot-Hawley Tariff”. Journal of Economic History, December 1997.